A minority shareholder in a closely held corporation is subject to abuse at the hands of the majority.  Courts and legislatures, however, have given some relief from majority shareholder oppression.

In 1975, the Supreme Judicial Court of Massachusetts held that shareholders in a closely held corporation owe to each other a fiduciary duty of “utmost good faith and loyalty.”  This is because in a close corporation there is potential for abuse and oppression of the minority shareholder.  The minority may be frozen out of dividends, employment opportunities or other benefits.  Because there is no ready market for the shares of a closely held corporation, the minority shareholder cannot readily extricate himself or herself from the corporation.  The Court noted that plight of the minority shareholder was untenable.  After recognizing the fiduciary duty, the Court held that if an opportunity is made available to a controlling shareholder (in that case, the repurchase of the controlling shareholder’s shares), that same opportunity must be made available to the minority shareholders.

In a later case the Court said that the “untempered application of the doctrine might interfere with legitimate corporate action.”  It therefore modified the law to permit controlling shareholders to show that a legitimate business purpose was served by the deed that harmed the minority.  The minority was then free to show that the business purpose could have been achieved by a less harmful alternative.  The Court stated that “[i]f called upon to settle a dispute, our courts must weigh the legitimate business purpose, if any, against the practicability of a less harmful alternative.”

In the more than 35 years since the doctrine was first articulated, many oppressed shareholders in Massachusetts have obtained relief for breach of fiduciary duty.  To circumvent this doctrine (and also for other reasons) many venture capitalists insist that their investments be in corporations incorporated in Delaware where the doctrine does not apply.

While this is the Massachusetts law, other states, either by case law as in Massachusetts or by statute have come to the same conclusion.  I successfully represented minority shareholders in two oppression cases in New Jersey under a statute that provided that, in a corporation having 25 or fewer shareholders, if directors or those in control have “acted oppressively or unfairly toward one or more minority shareholders,” then a court could grant the minority relief.

Posted July 25, 2011 by Edmund Polubinski, Jr.